IU: This is about expected returns, which are diminishing as these stock indexes keep hitting all-time highs.
Bernstein: Exactly. And that’s my idea for 2014. It will also be my idea for 2015, 2016, 2017 and even 2037, if I’m around.
IU: Until there’s “blood in the streets,” as you like to say?
Bernstein: Yes, exactly—until the process reverses.
IU: So how systematic do you make this “taking risk off the table”?
Bernstein: It’s really a problem in engineering. If the stock market goes up X percent, you want to decrease your asset allocation by Y percent. What’s the ratio between X and Y? If the market goes up 50 percent, maybe I want to reduce my stock allocation by 4 percent. So there’s a 12.5 ratio between those two numbers. Well, that’s what it really all boils down to: What’s your ratio between those two numbers?
IU: So 50 percent increase in the market might make you want to take 4 percent of the risk off the table?
Bernstein: Something like that: 4 percent, 2 percent or 5 percent; pick your number, pick your ratio.
IU: It seems like a typical investor isn’t going to look at it the way you just did. I’m thinking of some headline I read about Carl Icahn saying the market has gone up considerably. There might be a very big pullback. It’s infused with drama. You’re not buying that, are you?
Bernstein: No, no, no. Bob Shiller said there was irrational exuberance in the market in 1996. And then Greenspan took up the phrase that Shiller invented. Shiller was right; he was just four years early. So the answer was not to sell all your stocks in 1996.
If you did that, you probably didn’t do well. But you needed to start cutting back in ’96, a little more in ’97, a little more in ’98, a little more in ’99, a little more in 2000. The idea is that if you worked your way, say, from 60/40 down to 40/60 when 2000 came, well, you felt pretty smart.
IU: And this is precisely what intelligent money management should look like? It sure looks good in the rearview mirror, but it takes a certain amount of courage to be doing that before the bottom falls out.
Bernstein: Yes, when the intelligent investor does some trimming back, he usually feels like a dummy for the next year or two. And when he trims back again, he feels like a little bit more of a dummy. And he feels dumb for awhile each time after he does it. But then there comes a point, three to five years hence, when he feels awfully smart.
IU: It’s delayed gratification.